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How TPG Capital (formerly Texas Pacific Group) Lost $2.0 Billion At ...
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A few weeks ago, ahead of the second anniversary of Lehman Brothers collapse, I went back into my files to reread what I'd written during 2008 to see if there were any lessons to be learned that hadn't already been tackled in the book explosion arising from the financial crisis.

That led me to ask, "If the bet against the housing market by folks like Steve Eisman was 'The Big Short,' what was 'The Wrong Long'?" -- or the worst investment made during the crisis?

While there were lots of candidates, including the purchases of Citigroup (C) preferred by the Abu Dhabi sovereign wealth fund, one deal really stood out: the $7 billion investment in Washington Mutual (WFC) by a group of investors, led by private equity firm TPG.

In April 2008, following the merger of failing investment bank Bear Stearns with JPMorgan (JPM), TPG put $2.0 billion of its own money in WaMu, and in its May letter to investors that year, TPG wrote:

"We are enthusiastic about the opportunity to invest in an undervalued and attractive deposit franchise, particularly in a security with meaningful downside protection."

Not six months later, despite "meaningful downside protection," the investment "vanished," as the New York Times put it at the time, when banking regulators seized WaMu and sold its banking assets to JPMorgan. And in its third quarter 2008 letter, following WaMu's failure and the write off of its investment, TPG offered its investors the following explanation as to what happened:

"The unprecedented turmoil in global financial markets and resulting macro crisis of confidence has radically changed the dynamics of all financial institutions and led to widespread losses among investors throughout the sector."

Admittedly, TPG was hardly alone in its suffering from the rippling failures of Fannie Mae, Freddie Mac, Lehman Brothers, The Reserve Fund and AIG (AIG), but I think it's fair to say that if anyone could have made a good investment in WaMu, it should have been TPG.

TPG's founder David Bonderman had served on the WaMu board from 1997 to 2002 and the firm knew the mortgage/thrift industry particularly well. Mr. Bonderman, and Jim Coulter, TPG's co-founder, had made huge money when they worked for Texas billionaire Robert Bass, investing $150 million in American Savings and Loan and selling out for a multitude of that amount to none other than WaMu, and nearly doubling WaMu's size in the process.

So what did TPG miss? What was its fatal flaw in making one of the largest, fastest-vanishing investments in financial services history?

Ironically, I think that a large contributor to TPG's failure was Bonderman and Coulter's own success with American Savings. If the press-release quote above is any indicator, what TPG thought it was buying was "an undervalued and attractive deposit franchise" which is precisely what Bonderman and Coulter bought at American Savings Bank.

The difference, though, was that at American Savings, Bonderman and Coulter bought the carcass of a dead animal -- American Savings had already failed (still one of the largest bank failures in US history) and the FDIC had put $5.7 billion into the bank before the deal with Bass was closed. With WaMu, TPG was investing in a sick, but not yet dead, bank.

Going in as and when it did, TPG must have believed WaMu's falling knife had fallen far enough, that WaMu's assets (largely mortgage loans) had already been written down so much that what the firm was paying for wasn't WaMu's loans at all, but the bank's deposit-generating machine.

And, to be fair to TPG, it also thought it had protected itself adequately if things got worse. The firm went in with warrants which would offset the risk of further dilution if WaMu had to issue additional common. So, as long as WaMu was alive, TPG would be fine, even if other common shareholders were eviscerated.

Coming on the heels of the sale of Bear Stearns to JPMorgan, that probably looked like a reasonable assumption: Bonderman and Coulter likely thought that their downside scenario was a Bear Stearns-like deal for WaMu -- especially since WaMu wasn't that much smaller than Bear. If the US government wouldn't let Bear fail, the US government would not let WaMu fail.

Until it did.

In hindsight, TPG woefully missed the true asset quality and liquidity challenges facing WaMu. As one friend in the industry wrote to me last week, "[TPG] underestimated the scale of the credit crisis. Compared to all the other credit cycles since WW II (relatively swift, always ending with implicit/explicit backstop by authorities (the Fed, the FDIC, the Treasury), the current credit cycle is massive in scale (in terms of time and price). When you underestimate the scale, you are too early, pay too much, and under-appreciate the ability of authorities to backstop."

Going one step further, another banking industry friend of mine added "The strikingly different treatment of debt and equity investors in WaMu, Lehman, AIG, GMAC, etc. emphasizes the true nature of regulatory risk, particularly in market-crisis circumstances. You just don't know what they're going to do and the decisions are not bound to consistency or systemic rationale."

This past Saturday marked the second anniversary of WaMu's collapse, and I have to say that it's been an interesting weekend for me trying to reconcile "The Fatal Flaws" from "The Wrong Long" with a two-headed coin scenario -- one in which there's very limited downside for stocks because of the Federal Reserve -- which David Tepper offered on Friday morning.

In April 2008, TPG misread the magnitude of the crisis and thought it would be saved by the government. As I look around the investing landscape today, those "fatal flaws" feel eerily familiar, particularly with regards to European sovereign debt. And just part of me wonders whether two years from now I'll be writing yet another article for Minyanville entitled "The Wrong Long -- The Encore Production: The Sovereign Wealth Fund of Norway's Purchase of 'PIIG' Sovereign Debt, Because It Was So Cheap" and including this quote from the Norwegian fund's 2011 annual report:

"The unprecedented turmoil in global financial markets and resulting macro crisis of confidence has radically changed the dynamics for all sovereign borrowers and led to widespread losses among investors throughout the sector."

I suppose time will tell.

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Read more: http://www.minyanville.com/businessmarkets/articles/tpg-capital-texas-pacific-group-washington/9/27/2010/id/30262?page=full#ixzz3OSWHs1Om